FOMC to cut but tone of message and liquidity measures key

USD: A cut with what else?

The US dollar fell from its November high as it became clear that the FOMC was still likely to cut the fed funds rate despite the stronger than expected NFP report that was released on 20th November. The DXY November high was set on 21st November before turning weaker the same day in response to a comment from New York Fed President Williams that the Fed has room for further adjustments in the policy rate.

There is currently 23bps of cuts priced for tonight so a 25bp cut will bring little market reaction. The key factors to watch as usual outside of that decision will be the tone of the statement, the details of the Summary of Economic Projections (SEPs), including the dots profile, and the press conference itself. The dots profile in the last SEPs published in September showed two further cuts from the Fed this year – which will be delivered if we get a cut this evening – and one further cut in both 2026 and 2027 taking the fed funds rate to 3.125%, close to the 3.0% longer-run estimate. The FOMC is certainly divided at present and in that sense it could well be that the dots profile is broadly unchanged given the profile has the fed funds rate getting to the long-run neutral level gradually over time.

The statement opening summary paragraph may well also remain unchanged given inflation remains around the same level while the jobs data has been mixed and remains consistent with the view that job gains “have slowed this year”. Given the divisions over the outlook it will be difficult for Powell to send a strong message of pause but no doubt by reaching a consensus to cut the message will certainly be that the Fed have been pro-active and can now assess incoming data. Being data-dependent though will likely also remain a key part of the communication which will reinforce the importance of the two payroll reports being released next week.

The other issue of focus will be the balance sheet. QT came to an end effective 1^st December but as can be seen in the chart above, the sofr-fed funds spread has been volatile and is certainly indicative of increased liquidity strains that may be a sign of reserves not being ample enough. There has been speculation of some form of “Reserve Management Purchase” program being announced or a term facility to provide liquidity over periods of illiquidity. NY Fed President Williams stated that reserves were now near ample and therefore more liquidity adds could be required. Given the sharp increase in US T-bill issuance since the summer, increase purchases by the Fed could be a measure announced, although this meeting may be a little soon for a formal announcement.

Action in a direction of expanding the balance sheet would not be communicated as QE and would be more measured but would certainly be seen as a liquidity add that weighs on the US dollar going forward. How forceful Powell communicates a message of pause is likely most important for the dollar but steps to add liquidity to the markets could also play a role in FX reaction.

TIGHTENING LIQUIDITY SEEN THROUGH SOFR-FED FUNDS SPREAD VOLATILITY COULD SEE FED TAKE ACTION TONIGHT

Source: Bloomberg, Macrobond & MUFG GMR

CAD: BoC to pause

The Bank of Canada has cut by 100bps this year taking the key policy rate to 2.25% - two cuts came toward the start of the year with two at the last two meetings in September and October but the flow of data of late suggests the BoC may well be content with the stance of monetary policy. Canada is one of the growing list of countries where the OIS curve shows pricing for a rate hike at some stage in 2026. A 25bp rate hike is fully priced by the October 2026 meeting. A month ago the OIS market was still leaning slightly toward the risk of another cut. This shift in expectations is providing some support for CAD, which is currently the third best performing G10 currency on a month-to-date basis.

The turnaround in the labour market has been a key driver in policy rate expectations. The jobs market revealed a 53.6k increase in jobs in November after a 66.6k increase in October. The market expected a small drop. The September print was also strong with the 3mth average at 60k. The unemployment rate has now dropped from a peak of 7.1% to 6.5%. Q3 real GDP also came in much stronger than expected (2.6% vs 0.5% SAAR) with substantial revisions to the end of 2024.

This is quite a favourable macro backdrop for this BoC meeting – perhaps the best since Governor Macklem started in his role in June 2020. This should mean the tone today will be more skewed to a stronger message of pause than at the last meeting given the labour market data. But the BoC still has reason for caution – the health of the US economy remains unclear and the USMCA agreement is up for renegotiation next year which could reinforce trade uncertainties. Taking a leaf out of the ECB book to indicate policy is “in a good place” or something along that line makes sense. We certainly would not expect any endorsement of the rate hike pricing for next year – that seems much too soon for the BoC to endorse.

CAD is the fourth worst performing G10 currency in 2025 and a strong message of pause if matched with further positive data could result in some additional CAD outperformance over the short-term.

SHORT-TERM RATE SPREAD MOVES SUPPORTIVE OF CAD GAINS AS MACRO BACKDROP IMPROVES IN CANADA

Source: Bloomberg, Macrobond & MUFG GMR

KEY RELEASES AND EVENTS

Source: Bloomberg & Investing.com